Acquisition - Defense Technical Information Center

Acquisition

Department of DefenseOffice of the Inspector General

October 16, 2003

AccountabilityIntegrityQuality

Sole-Source Spare Parts Procured From an Exclusive Distributor(D-2004-012)

This special version of the report has beenrevised to omit contractor proprietary data.

Report Documentation Page Form ApprovedOMB No. 0704-0188

Public reporting burden for the collection of information is estimated to average 1 hour per response, including the time for reviewing instructions, searching existing data sources, gathering andmaintaining the data needed, and completing and reviewing the collection of information. Send comments regarding this burden estimate or any other aspect of this collection of information,including suggestions for reducing this burden, to Washington Headquarters Services, Directorate for Information Operations and Reports, 1215 Jefferson Davis Highway, Suite 1204, ArlingtonVA 22202-4302. Respondents should be aware that notwithstanding any other provision of law, no person shall be subject to a penalty for failing to comply with a collection of information if itdoes not display a currently valid OMB control number.

1. REPORT DATE 16 OCT 2003

2. REPORT TYPE N/A

3. DATES COVERED -

4. TITLE AND SUBTITLE Acquisition: Sole-Source Spare Parts Procured From an ExclusiveDistributor (D-2004-012)

5a. CONTRACT NUMBER

5b. GRANT NUMBER

5c. PROGRAM ELEMENT NUMBER

6. AUTHOR(S) 5d. PROJECT NUMBER

5e. TASK NUMBER

5f. WORK UNIT NUMBER

7. PERFORMING ORGANIZATION NAME(S) AND ADDRESS(ES) DoD-IG ODIG-AUD (AFTS) Secondary Reports Distribution 400 ArmyNavy Drive (801) Arlington, VA 22202-4704

8. PERFORMING ORGANIZATIONREPORT NUMBER D-2004-012

9. SPONSORING/MONITORING AGENCY NAME(S) AND ADDRESS(ES) 10. SPONSOR/MONITOR’S ACRONYM(S)

11. SPONSOR/MONITOR’S REPORT NUMBER(S)

12. DISTRIBUTION/AVAILABILITY STATEMENT Approved for public release, distribution unlimited

13. SUPPLEMENTARY NOTES

14. ABSTRACT This report should be of particular interest to DoD acquisition, logistics, and contracting officials because itconcerns procuring and supplying sole-source spare parts at fair and reasonable prices.

15. SUBJECT TERMS

16. SECURITY CLASSIFICATION OF: 17. LIMITATION OF ABSTRACT

UU

18. NUMBEROF PAGES

59

19a. NAME OFRESPONSIBLE PERSON

a. REPORT unclassified

b. ABSTRACT unclassified

c. THIS PAGE unclassified

Standard Form 298 (Rev. 8-98) Prescribed by ANSI Std Z39-18

Additional Copies To request additional copies of this report, contact Henry F. Kleinknecht at (703) 604-9324 (DSN 664-9324) or Ronald W. Hodges at (703) 604-9592 (DSN 664-9592). Suggestions for Future Audits To suggest ideas for or to request future audits, contact the Audit Followup and Technical Support Directorate at (703) 604-8940 (DSN 664-8940) or fax (703) 604-8932. Ideas and requests can also be mailed to:

ODIG-AUD (ATTN: AFTS Audit Suggestions) Inspector General of the Department of Defense

400 Army Navy Drive (Room 801) Arlington, VA 22202-4704

Defense Hotline To report fraud, waste, or abuse, contact the Defense Hotline by calling (800) 424-9098; by sending an electronic message to [email protected]; or by writing to the Defense Hotline, The Pentagon, Washington, DC 20301-1900. The identity of each writer and caller is fully protected.

Acronyms

AMCOM Army Aviation and Missile Command DCAA Defense Contract Audit Agency DCMO Defense Contract Management Office DLA Defense Logistics Agency DSCC Defense Supply Center Columbus DSCP Defense Supply Center Philadelphia DSCR Defense Supply Center Richmond FAR Federal Acquisition Regulation GAO General Accounting Office NSN National Stock Number OEM Original Equipment Manufacturer SSA Strategic Supplier Alliance

Office of the Inspector General of the Department of Defense

Report No. D-2004-012 October 16, 2003 Project No.(D2002CH-0029.000)

Sole-Source Spare Parts Procured From an Exclusive Distributor

Executive Summary

Who Should Read This Report and Why? This report should be of particular interest to DoD acquisition, logistics, and contracting officials because it concerns procuring and supplying sole-source spare parts at fair and reasonable prices.

Background. This report is one in a series of reports issued during the last 6 years that involve commercial and noncommercial pricing of spare parts and other logistics support initiatives. This report discusses the reasonableness of prices paid for spare parts from AAR Defense Systems, an exclusive distributor for Hamilton Sundstrand, which is a subsidiary of United Technologies Corporation. In FY 2001, United Technologies Corporation was the sixth largest contractor for DoD with about $3.7 billion in contract awards.

Starting in 1996, Hamilton Sundstrand entered into multiple agreements with AAR Defense Systems as the exclusive distributor of designated spare parts. Under the agreement, contracting officers for the Army Aviation and Missile Command and the Defense Logistics Agency procure sole-source Hamilton Sundstrand parts directly from AAR Defense Systems. Our review focused on 35 orders (29 contracts) for 11 sole-source Hamilton Sundstrand spare parts (National Stock Numbers) procured from AAR Defense Systems during March 1999 through August 2002 with a total value of $16.8 million. In that same period, DoD awarded 311 orders for 89 sole-source Hamilton Sundstrand spare parts to AAR Defense Systems with a total value of $57.6 million.

Results. Contracting officers for the Army Aviation and Missile Command and the Defense Supply Centers followed established procedures and with available information generally determined prices fair and reasonable for sole-source spare parts procured from AAR Defense Systems. However, based on information we obtained not available to contracting officers for the Army Aviation and Missile Command and the Defense Supply Centers, the prices were too high. As a result, DoD paid $16.8 million instead of $ 1 million, or 1 percent ($ 1 million), more than fair and reasonable prices. Based on annual demand and the most recent prices paid, we calculate that DoD will pay about $22.2 million, or 1 percent, more than fair and reasonable prices for the same items in FY 2004 through FY 2009, if the problems are not corrected. The AAR Defense Systems average pass-through costs of 1 percent represent $ 1 million of the $22.2 million. The Commander, Army Aviation and Missile Command and the Director, Defense Logistics Agency should emphasize with their contracting officers the need to revisit procuring sole-source Hamilton Sundstrand spare parts from a distributor versus directly from the original equipment manufacturer unless the distributor can provide sufficient value to DoD in line with the additional pass-through costs. Contracting officers should also

1This figure was calculated using contractor proprietary data and has been deleted.

ii

obtain information that is adequate to evaluate reasonableness of price in accordance with Federal Acquisition Regulation requirements. The information--information other than cost or pricing data--includes uncertified cost or pricing data that can be used to perform cost analysis. The Army and the Defense Logistics Agency should also emphasize with their contracting officers the need to document and escalate negotiations in instances where the original equipment manufacturer is either unreasonable or uncooperative and refuses to quote an item or refuses to supply information other than cost or pricing data, as required. The Army and the Defense Logistics Agency, in conjunction with the Air Force, should consider initiating action that implements a new Strategic Supplier Alliance with either AAR Defense Systems or Hamilton Sundstrand. (See the Finding section of the report for the detailed recommendations.)

Management Comments and Audit Response. The Defense Logistics Agency concurred with the audit finding and intent of the recommendations. Specifically, the Director of Logistics Operations agreed that based on the Hamilton Sundstrand cost data supplied to the Office of the Inspector General of the Department of Defense, prices paid were more than what could be considered fair and reasonable. However, the Director of Logistics Operations emphasized that the data were not available to the contracting officers. We agreed and revised the finding to reflect that the information was not made available to contracting officers. The Defense Logistics Agency is implementing a Strategic Supplier Alliance with Hamilton Sundstrand and believes the success of the alliance will satisfy the intent of our recommendations. We agree and consider the Defense Logistics Agency comments responsive. The Army did not agree with either the finding or the recommendations and the comments were generally not responsive. Specifically, the Deputy Assistant Secretary of the Army (Policy and Procurement) did not agree that fair and reasonable prices were not obtained for the four Army National Stock Numbers referenced in the report. The Army asserted that the Army Aviation and Missile Command complied with all the regulatory and statutory requirements in negotiating fair and reasonable prices. In addition, Army contracting officers requested, received, and used “information other than cost and pricing data” in support of determining price reasonableness. We agreed that Army Aviation and Missile Command contracting officers followed established procedures for determining prices fair and reasonable and revised the finding to reflect this. However, as discussed in the report, the information other than cost or pricing data requested, received, and upon which the Army relied were inaccurate and misleading. Consequently, based on the data we obtained from the original equipment manufacturer, we calculated that the Army should have paid $ 2 million versus $3.8 million, a difference of $ 2 million or 2 percent more than fair and reasonable prices. Accordingly, we request that the Army provide additional comments on the final report by December 15, 2003. See the Finding section of the report for a discussion of the management comments on the recommendations, Appendix D for management comments on the finding and our audit response, and the Management Comments section of the report for the complete text of the comments.


Table of Contents

Executive Summary i

Background 1

Objectives 2

Finding

Spare Parts Prices 3

Appendixes

A. Scope and Methodology 21 Management Control Program Review 22

B. Prior Coverage 23 C. Comparison of DoD Prices with Fair and Reasonable Prices 25 D. Management Comments on the Finding and Audit Response 28 E. Report Distribution 31

Management Comments

Defense Logistics Agency 33 Department of the Army 40

1

Background

During the last 6 years, the Office of the Inspector General of the Department of Defense (IG DoD) has worked closely with the Defense Logistics Agency (DLA) and other DoD Components to achieve fair and reasonable pricing for sole-source commercial and noncommercial spare parts. This report discusses the reasonableness of prices paid for spare parts procured from AAR Defense Systems, an exclusive distributor for Hamilton Sundstrand, which is a subsidiary of United Technologies Corporation. United Technologies was the sixth largest DoD contractor with $3.7 billion in DoD contracts in FY 2001.

Hamilton Sundstrand. Hamilton Sundstrand designs, manufactures, and supports aerospace and industrial products to include spare parts, overhaul and repair, and engineering and technical support. Hamilton Sundstrand is an original equipment manufacturer (OEM) of sole-source spare parts the Army Aviation and Missile Command (AMCOM), DLA, and other DoD Components procured. Starting in 1996, Hamilton Sundstrand entered into multiple agreements with AAR Defense Systems as the exclusive distributor of designated sole-source spare parts, where DoD would procure the parts directly from AAR Defense Systems.

AAR Defense Systems. AAR Defense Systems, a military supplier, dealer, distributor, and maintenance program manager for aircraft and engine parts and components, is the exclusive distributor of designated spare parts for Hamilton Sundstrand. The distributor agreement applies to sales only for U.S. Government requirements. As a result, both AMCOM and the DLA Defense Supply Centers procured spare parts from AAR Defense Systems, which was acting as a distributor for Hamilton Sundstrand. AAR Defense Systems representatives stated they have various agreements with Hamilton Sundstrand as an exclusive distributor of sole-source spare parts for users other than DoD.

Army Aviation and Missile Command. AMCOM is a major subordinate command of the Army Materiel Command. AMCOM is headquartered at Redstone Arsenal in Huntsville, Alabama. In partnership with Program Executive Offices and Program Managers, AMCOM ensures the Army’s readiness by developing, acquiring, and fielding Army aviation and missile systems. AMCOM provides engineering, logistics, and acquisition services to accomplish those tasks. AMCOM services cover more than 90 major systems, about half of the systems in the Army today, which includes critical Army aviation spare parts. For FY 2001, the AMCOM budget at Redstone Arsenal exceeded $7.1 billion. AMCOM is the leader in the Army’s foreign military sales and accounts for more than 50 percent of total Army sales to allied forces and to friendly foreign nations.

Defense Logistics Agency. DLA provides worldwide logistics support for the Military Departments and the unified combatant commands in peace and war. DLA has 11 field offices, 3 of which are involved in the procurement of spare parts. The three field offices are the Defense Supply Center Columbus (DSCC), the Defense Supply Center Philadelphia (DSCP), and the Defense Supply Center Richmond (DSCR). DSCC supplies weapon systems spare parts and end items and manages almost 1.8 million different construction and electronic spare parts.

2

DSCP provides U.S. Service members with food, clothing, textiles, medicines, medical equipment, and general and industrial supplies, and supports U.S. humanitarian and disaster relief efforts. DSCR is the lead center for aviation weapon systems and environmental logistics support and is the primary supply source for nearly 930,000 repair parts and operating items. DSCC, DSCP, and DSCR have each contracted for spare parts Hamilton Sundstrand manufactured.

Spare Parts Reviewed. We reviewed 35 orders (29 contracts) for 11 sole-source Hamilton Sundstrand spare parts (National Stock Numbers [NSNs]) procured from AAR Defense Systems from March 1999 through August 2002 with a total value of $16.8 million. Table 1 shows the buying activity and spare parts reviewed.

Table 1. Buying Activity and NSNs Reviewed Item No.

Buying Activity

NSN

Item Description

Weapon System

1 AMCOM 2835-01-106-9153 Shaft Assembly UH-60 Helicopter 2 AMCOM 2835-01-106-9156 Turbine Nozzle Assembly UH-60 Helicopter 3 AMCOM 2835-01-419-2118 Housing Reduction UH-60 Helicopter 4 AMCOM 2835-00-176-8867 Air Inlet and Sleeve CH-47 Helicopter 5 DSCC 2520-00-153-2652 Cylinder Block Assembly Amphibious Assault Vehicle 6 DSCP 3595-01-446-8522 Jet Fuel Starter Repair Kit F-16 Fighter Aircraft 7 DSCR 2835-00-015-8599 Combustion Chamber Case CH-46, CH-47, and H-3

Helicopters 8 DSCR 2835-01-462-3375 Compressor Wheel CH-47 Helicopter 9 DSCR 2835-00-104-7376 Turbine Nozzle CH-53 Helicopter

10 DSCR 2835-00-962-5838 Turbine Nozzle CH-46 Helicopter 11 DSCR 2835-00-963-1393 Pinion Accessory Drive CH-46 and CH-53

Helicopters

Objectives

The overall objective was to determine whether DoD is paying fair and reasonable prices for sole-source commercial and noncommercial spare parts procured from AAR Defense Systems. We also reviewed the management control program as it related to our overall objective. See Appendix A for a discussion of the audit scope and methodology and management controls. See Appendix B for prior coverage related to the objectives.

3

Spare Parts Prices Contracting officers for AMCOM and DLA followed established procedures and with available information generally determined prices fair and reasonable for sole-source spare parts procured from AAR Defense Systems--an exclusive distributor for Hamilton Sundstrand. However, based on information we obtained that was not available to the contracting officers for AMCOM and DLA, the prices were too high. The prices for commercial or noncommercial spare parts were too high because contracting officers:

• were directed by the OEM, Hamilton Sundstrand (which declined to give a quote) to procure spare parts through its exclusive distributor, AAR Defense Systems, even though the distributor provided limited value to DoD;

• relied on inaccurate and misleading information other than cost or pricing data AAR Defense Systems provided that originated from Hamilton Sundstrand and failed to perform cost analysis of OEM prices to determine price reasonableness; and

• failed to sufficiently document and escalate negotiations in cases where the behavior of the OEM was either unreasonable or uncooperative.

AMCOM and DLA also did not establish a Strategic Supplier Alliance (SSA) with either AAR Defense Systems or Hamilton Sundstrand. As a result, AMCOM and DLA paid $16.8 million instead of $ 3 million, or 3 percent ($ 3 million), more than fair and reasonable prices on 35 orders (29 contracts) for 11 sole-source Hamilton Sundstrand spare parts procured from AAR Defense Systems from March 1999 through August 2002. Based on annual demand and the most recent prices paid, we calculate that DoD will pay about $22.2 million, or 3 percent more than fair and reasonable prices for the same items in FY 2004 through FY 2009, if the problems are not corrected. The AAR Defense Systems average pass-through costs ( 3 percent) represent $ 3 million of the $22.2 million.

Guidance on Commercial Items

Commercial Item Definition. The Federal Acquisition Regulation (FAR) Subpart 2.1, “Definitions,” defines commercial items.

“Commercial item” means


4

(1) Any item, other than real property, that is of a type customarily used by the general public or by non-governmental entities for purposes other than governmental purposes, and [Emphasis added.]

(i) Has been sold, leased, or licensed to the general public; or (ii) Has been offered for sale, lease, or license to the general public;

(2) Any item that evolved from an item described in paragraph (1) of this definition through advances in technology or performance and that is not yet available in the commercial marketplace, but will be available in the commercial marketplace in time to satisfy the delivery requirements under a Government solicitation;

(3) Any item that would satisfy a criterion expressed in paragraphs (1) or (2) of this definition, but for (i) Modifications of a type customarily available in the commercial marketplace; or (ii) Minor modifications of a type not customarily available in the commercial marketplace made to meet Federal Government requirements. Minor modifications means modifications that do not significantly alter the nongovernmental function or essential physical characteristics of an item or component, or change the purpose of a process. Factors to be considered in determining whether a modification is minor include the value and size of the modification and the comparative value and size of the final product. Dollar values and percentages may be used as guideposts, but are not conclusive evidence that a modification is minor;

“Information Other Than Cost or Pricing Data.” FAR Subpart 2.1, “Definitions,” also defines “information other than cost or pricing data.”

“Information other than cost or pricing data” means any type of information that is not required to be certified in accordance with 15.406-2 and is necessary to determine price reasonableness or cost realism. For example, such information may include pricing, sales, or cost information, and includes cost or pricing data for which certification is determined inapplicable after submission. [Emphasis added.]

FAR 15.403-3, “Requiring Information Other Than Cost or Pricing Data,” provides additional guidance on information necessary for evaluating the reasonableness of prices.

(a) General. (1) The contracting officer is responsible for obtaining information that is adequate for evaluating the reasonableness of the price or determining cost realism, but the contracting officer should not obtain more information than is necessary (see 15.402(a)). If the

5

contracting officer cannot obtain adequate information from sources other than the offeror, the contracting officer must require submission of information other than cost or pricing data from the offeror that is adequate to determine a fair and reasonable price (10 U.S.C. 2306a(d)(1) and 41 U.S.C. 254b(d)(1)). Unless an exception under 15.403-1(b)(1) or (2) applies, the contracting officer must require that the information submitted by the offeror include, at a minimum, appropriate information on the prices at which the same item or similar items have previously been sold, adequate for determining the reasonableness of the price. To determine the information an offeror should be required to submit, the contracting officer should consider the guidance in Section 3.3, Chapter 3, Volume I, of the Contract Pricing Reference Guide cited at 15.404-1(a)(7). (2) The contractor’s format for submitting the information should be used (see 15.403-5(b)(2)). (3) The contracting officer must ensure that information used to support price negotiations is sufficiently current to permit negotiation of a fair and reasonable price. Requests for updated offeror information should be limited to information that affects the adequacy of the proposal for negotiations, such as changes in price lists. (4) As specified in Section 808 of Public Law 105-261, an offeror who does not comply with a requirement to submit information for a contract or subcontract in accordance with paragraph (a)(1) of this subsection is ineligible for award unless the HCA [Head of Contracting Activity] determines that it is in the best interest of the Government to make the award to that offeror, based on consideration of the following: (i) The effort made to obtain the data. (ii) The need for the item or service. (iii) Increased cost or significant harm to the Government if award is not made. [Emphasis added.] (b) Adequate Price Competition [Omitted]

(c) Commercial items. (1) At a minimum, the contracting officer must use price analysis to determine whether the price is fair and reasonable whenever the contracting officer acquires a commercial item (see 15.404-1(b)). The fact that a price is included in a catalog does not in and of itself, make it fair and reasonable. If the contracting officer cannot determine whether an offered price is fair and reasonable, even after obtaining additional information from sources other than the offeror, then the contracting officer must require the offeror to submit information other than cost or pricing data to support further analysis (see 15.404-1). [Emphasis added.]

FAR 15.404-1, “Proposal Analysis Techniques,” provides that the objective of proposal analysis is to ensure that the final agreed-to-price is fair and reasonable and addresses cost analysis of “information other than cost or pricing data.”

6

(a) General. [Omitted.]

(4) Cost analysis may also be used to evaluate information other than cost or pricing data to determine cost reasonableness or cost realism. [Emphasis added.]

Additional Guidance on Commercial Items. The Under Secretary of Defense for Acquisition and Technology (renamed Acquisition, Technology, and Logistics) provided clarification of FAR guidance on commercial items for consistency including “Of a Type” and “Sole-Source Situations,” in a memo dated January 5, 2001, on “Commercial Acquisition.”

“Of a Type”: The phrase “of a type” is not intended to allow the use of FAR Part 12 to acquire sole-source, military unique items that are not closely related to items already in the marketplace. Instead, “of a type” broadens the commercial item definition so that qualifying items do not have to be identical to those in the commercial marketplace. The best value offer in a competitive Part 12 solicitation can be an item that has previously satisfied the Government’s need but has not been sold, leased, licensed, nor offered for sale, lease or license to the general public (a nondevelopmental item as defined in 10 USC 403 (13)). In this scenario, the phrase “of a type” allows the best value offer to qualify for a Part 12 contract as long as it is sufficiently like similar items that meet the government’s requirement and are sold, leased, licensed, or offered for sale, lease or license to the general public. In such instances, “of a type” broadens the statutory commercial item definition to allow Part 12 acquisition of a government-unique item that can compete with commercial items that meet the government’s requirement. This avoids the undesirable result of shutting out otherwise price-competitive preexisting suppliers of government-unique items from Part 12 solicitations. [Emphasis added.]

Sole-Source Situations: Contracting officers and requirements personnel should work together to avoid sole-source situations. Competition is enabled when needs are broadly stated in terms of performance outcomes. However, a sole-source situation may be unavoidable, presenting pricing challenges. Tools and techniques are available for assisting in the price reasonableness determination for sole-source commercial item procurements. Sometimes, sole-source suppliers may attempt to exploit the lack of competitive markets and demand unreasonable prices. In such circumstances, the team should consider revising negotiation strategies to consider innovative solutions (e.g., strategic supplier alliances); buying the bare minimum quantities and working to restate the need to expand possible solutions and qualify alternate suppliers; and ultimately upgrading systems to current, commercial technology. In some cases, it may be necessary to escalate negotiations. The first escalation should be to the Procurement Executive, then, if necessary, to the Head of the Agency. [Emphasis added.]

7

Commercial or Noncommercial Items

AAR Defense Systems, the prime contractor, classified each of the 11 sole-source Hamilton Sundstrand spare parts as commercial or commercial “of a type” items and performed no cost analysis of the OEM prices. We compared military and commercial sales of the parts for January 2000 through June 2002 to determine if a sufficient commercial market existed that would indicate whether the items were “customarily used by the general public or by non-governmental entities for purposes other than governmental purposes.” Hamilton Sundstrand could provide only commercial sales data on the same items for parts 2, 3, 7, and 11; commercial sales data for “of a type” items for parts 1, 4, 8, and 10; and could not provide commercial sales data for parts 5, 6, and 9. The commerciality of the parts is questionable based on guidance because the commercial market is clearly insufficient to support any price reasonableness determination.

Figure 1 shows that the volume of military sales were substantially higher than commercial sales for the same and “of a type” items.

Figure 1. Comparison of Military to Commercial Sales

Fair and Reasonable Prices

Although contracting officers for AMCOM and DLA followed established procedures and with available information generally determined prices fair and reasonable for sole-source spare parts procured from AAR Defense Systems, based on information we obtained that was not available to the contracting officers for AMCOM and DLA, the prices were too high. We obtained 2000, 2001, and 2002 cost standards (total manufacturing costs) from Hamilton Sundstrand for the 11 spare parts reviewed and calculated fair and reasonable prices from the OEM by adding approved military general and administrative

0

200

400

600

800

1000

1 2 3 4 5 6 7 8 9 10 11

Parts

Qua

ntity

Sol

d

Military SalesCommercial Sales

8

rates along with a profit margin (cost build-up price) determined by the auditors. Hamilton Sundstrand did not make the cost data available to either AAR Defense Systems or the DoD contracting officers. We compared OEM prices to the prices DoD paid to the exclusive distributor, AAR Defense Systems. The DoD prices ranged from 4 to 4 percent above the fair and reasonable price.

Figure 2 shows the percentages above a fair and reasonable price that AMCOM, DSCC, DSCP, and DSCR paid for the 35 orders (29 contracts) and 11 parts reviewed.

Figure 2. Percent Prices Were Above Fair and Reasonable Price

See Appendix C for a detailed comparison of DoD prices with fair and reasonable prices (cost build-up prices).

Procuring Spare Parts From a Distributor

The OEM, Hamilton Sundstrand (which declined to give a quote) directed that contracting officers for AMCOM and DLA procure spare parts through its distributor, AAR Defense Systems, even though AAR Defense Systems provided limited value to DoD. The AAR Defense Systems average pass-through costs (cost recovery and fee) added 4 percent to the DoD price.


0

4

4

4

4

4

4

4

Percent

AMCOM DSCC DSCR

2 3 4

5

6

78 9 10 11

DSCP

1

9

AAR Defense Systems and Hamilton Sundstrand Distributor Relationship. Starting in 1996, Hamilton Sundstrand entered into multiple agreements identifying AAR Defense Systems as its “exclusive distributor” for Government sales. The intent of the distributor relationship was for AAR to stock and distribute the parts as a support alternative other than DoD stockage. Specifically, the 1996 agreement stated:

Whereas, the various DoD buying agencies and other users of Sundstrand equipment, in efforts to reduce costs, are looking to industry to provide the stocking and distribution function, including the delivery of material directly to the user organizations, within days of requisition.

DoD Policy on Support Alternatives. The DoD Materiel Management Regulation, DoD 4140.1-R, “Support Alternatives Other Than DoD Stockage,” May 20, 1998, provides guidance on support alternatives other than DoD stockage. Section C3.4.2.1.1. states:

All alternatives for obtaining materiel support directly from commercial sources, consistent with weapon system readiness goals, shall be used wherever practical to minimize inventory stockage requirements and achieve cost-effective distribution of materiel. Commercial alternatives include satisfying demands by placing orders with vendors for direct shipment to customers, use of commercial distribution systems, GSA [General Services Administration] Federal Supply Schedules, and new or existing contractor logistics support arrangements.

OEM and Distributor Lead Times. AAR Defense Systems provided only limited stock and distribution functions and was not responsible for delivery of the parts directly to user organizations within days of requisition because these requirements were not in the Army or DLA contracts. Consequently, the Army and DLA had responsibility for these requirements.

Table 2 shows that the quoted delivery lead times from the OEM, Hamilton Sundstrand, to the distributor, AAR Defense Systems, were exactly the same as the delivery lead times from the distributor to the Government. We did not have the OEM proposal to AAR Defense Systems for parts 7 and 9.

10

Table 2. OEM and Distributor Quoted Lead Times Are the Same (after receipt of order) OEM to Distributor Distributor to Government Item No. NSN Quantity Delivery Quantity Delivery

1 2835-01-106-9153 100 - 200 5 months 100 5 months

2 2835-01-106-9156 90 5 months 90 5 months

3 2835-01-419-2118 3-80 5 months 75 5 months

4 2835-00-176-8867 5-40 5 months 30 5 months

5 2520-00-153-2652 75 5 months 75 5 months

6 2835-01-446-8522 5-400 5 months 90 5 months

8 2835-01-462-3375 1-400 5 months 380 5 months

10 2835-00-962-5838 10-50 5 months 39 5 months

11 2835-00-963-1393 5-110 5 months 97 5 months

Contracting officers for AMCOM and DLA need to initiate action that procures sole-source Hamilton Sundstrand spare parts directly from the OEM or develops a business case supporting the use of an exclusive distributor to provide inventory stockage and materiel distribution requirements. In June 2002, we visited AAR Defense Systems headquarters. During the visit, we performed a physical inventory and did not identify any on-hand inventory that would enable AAR Defense Systems to ship inventory within days of requisition to satisfy Government requirements.

AAR Defense Systems personnel stated that they have provided added value in their role as an exclusive distributor of sole source spare parts. In February 2003, AAR Defense Systems had 14 units in inventory for only 1 of the 11 spare parts we reviewed. AAR Defense Systems also stated that they improved lead times by expediting deliveries of sole-source Hamilton Sundstrand spare parts prior to DoD awarding a signed contract to AAR Defense Systems. We agree that AAR Defense Systems has provided limited value added in situations when they anticipated the award of a future DoD contract.

5This represents contractor proprietary data that has been deleted.

11

However, using both DoD and AAR Defense Systems infrastructure for stocking spare parts is not an effective use of resources when both add similar costs to the price of the parts.

“Information Other Than Cost or Pricing Data”

Contracting officers relied on inaccurate and misleading information other than cost or pricing data AAR Defense Systems provided that originated from Hamilton Sundstrand and did not perform cost analysis of OEM prices that would determine price reasonableness. AAR Defense Systems did not provide contracting officers for AMCOM and DLA adequate information other than cost and pricing data that included uncertified cost or pricing data from Hamilton Sundstrand.

Price Reasonableness Determinations. AMCOM contracting officers determined that prices for each of the spare parts were fair and reasonable. DSCR contracting officers, lacking sufficient information and data to make price reasonableness determinations, classified prices for orders on four out of the five DSCR parts reviewed as either unreasonable or could not determine price reasonableness. Unfortunately, there were critical requirements for the parts so the procurements were made at unreasonable prices. Catalog prices with price analysis supported other orders.

Information Other Than Cost or Pricing Data Provided by AAR. The information other than cost or pricing data that AAR Defense Systems provided to DoD contracting officers contained inaccurate and misleading information because the data were irrelevant to the Hamilton Sundstrand price. The data indicated that Hamilton Sundstrand prices were based on some type of cost buildup. Hamilton Sundstrand stated during the audit that prices were price-based and not based on any type of cost buildup where profit was evaluated. DoD contracting officers questioned price increases; however, AAR Defense Systems provided information that supported the increases by stating that Hamilton Sundstrand had revised its material acquisition rate, rates utilized in the proposal had been negotiated with Defense Contract Management Office (DCMO) and Defense Contract Audit Agency (DCAA) offices, and price increases reflected escalation, profit, and increases in material handling.

For example, an AMCOM contracting officer questioned the price for NSN 2835-01-106-9153 on contract DAAH23-00-P-0066. The Government had paid a unit price of $613.81 for the shaft assembly in June 1992; the new unit price for 30 shaft assemblies was $2,372 for a total contract price of $71,160. AMCOM had a critical requirement for the part, and the contracting officer relied on information other than cost or pricing data for pricing the item and determining price reasonableness.

Table 3 shows the data AAR Defense Systems provided that supported price reasonableness where no cost analysis of the Hamilton Sundstrand price was performed.

12

Table 3. AAR Other Than Cost or Pricing Data Description Percent Amount

AAR Cost (Hamilton Sundstrand Price) $ 6 Selling/General and Administrative Expense 6 $ 6 Subtotal $ 6 Fee 6 $ 6 Unit price before economic concession $ 6 AAR economic price concession ($ 6 ) Net Price $2,371.77

To support the Hamilton Sundstrand price, AAR Defense Systems provided the following information from Hamilton Sundstrand:

Hamilton Sundstrand Material Acquisition Rate

7

The statement submitted in relationship to the price implies that Hamilton Sundstrand used some type of a cost buildup. While the statement was technically correct, no relationship existed between the statement and the Hamilton Sundstrand price. Consequently, the information AAR Defense Systems provided to the AMCOM contracting officer was irrelevant and of no value because the Hamilton Sundstrand price was not based on a cost buildup. Using a cost buildup, we calculated that the fair and reasonable unit price for the item from Hamilton Sundstrand was $ 8 versus the AAR Defense Systems distributor price of $2,372.00 or a difference of 8 percent.

An AMCOM contracting officer also questioned the price for NSN 2835-01-106-9156 on contract DAAH23-00-P-1175. The contract was for 90 turbine nozzles at a unit price of $4,815.84 for a total contract price of $433,426.

Table 4 shows the data AAR Defense Systems provided that supported price reasonableness. Again, no cost analysis of the Hamilton Sundstrand price was performed.

6This figure represents contractor proprietary data that has been deleted. 7This area of the report represents contractor proprietary data that has been deleted. 8This figure was calculated using contractor proprietary data and has been deleted.

13

Table 4. AAR Other Than Cost or Pricing Data Description Percent Basic Option*

AAR Cost (Hamilton Sundstrand Price) $ 9 $ 9 Selling/General and Administrative Expense 9 9 9 Subtotal $ 9 $ 9 Fee 9 9 9 Unit price before economic concession 9 9 AAR economic price concession ( 9 ) ( 9 ) Net Price $4,815.84 $4,936.24 Extended Price $433,425.62 $444,261.78 *The AAR source document contained mathematical errors for the option year.

To support the Hamilton Sundstrand price, AAR Defense Systems provided the AMCOM contracting officer with the following information AAR Defense Systems received from Hamilton Sundstrand that was included in the price negotiation memorandum.

10

The statement again implies that the Hamilton Sundstrand price was based on a cost buildup. However, the information AAR Defense Systems provided to an AMCOM contracting officer was irrelevant and of no value because the Hamilton Sundstrand price was not based on a cost buildup. We calculated, using a cost buildup, that the fair and reasonable unit price for the item from Hamilton Sundstrand was $ 11 in 2000 and $ 11 in 2001 versus the AAR Defense Systems’ price of $4,815.84 and $4,936.24, a difference of 11 and 11 percent, respectively.

The DSCR contracting officer questioned the price for NSN 2835-00-962-5838 on contract SP0480-00-G-0001 (delivery order TY66). The order was for 39 turbine nozzles at a unit price of $4,567.75 for a total contract price of $178,142. The order also included an option quantity of 39 items at a unit price of $4,796.15 for a total option price of $187,050. Table 5 shows the data provided by AAR Defense Systems to support price reasonableness without cost analysis of the Hamilton Sundstrand price.


14

Table 5. AAR Other Than Cost or Pricing Data Description Percent Amount

Basic Option Quantity 39 39 AAR Cost (Hamilton Sundstrand Price) $ 12 $ 12 Selling/General and Administrative Expense 12 12 12 Subtotal $ 12 $ 12 Fee 12 12 12 Unit price before economic concession 12 12 AAR economic price concession ( 12 ) ( 12 )

Net Price $4,681.00 $4,915.05

On April 12, 2001, AAR Defense Systems lowered its basic unit price to $4,567.75 and option unit price to $4,796.15. AAR Defense Systems provided the following information it received from Hamilton Sundstrand:

13

The DSCR contracting officer determined that the price was fair and reasonable using price analysis and the information AAR Defense Systems provided. Again, the information AAR Defense Systems provided to the DSCR contracting officer had no reasonable relationship to the Hamilton Sundstrand cost to manufacture the part. We calculated that a fair and reasonable unit price for the item from Hamilton Sundstrand was $ 14 versus the AAR Defense Systems distributor prices of $4,567.75 and $4,796.15, or differences of 14 and 14 percent, respectively.

Contracting officers for AMCOM and DLA need to comply with FAR requirements for obtaining information that is adequate for evaluating the reasonableness of price. This information--information other than cost or pricing data--includes uncertified cost or pricing data that can be used to perform cost analysis that supports price reasonableness determinations.

Document and Escalate Negotiations

Contracting officers for AMCOM and DLA failed to sufficiently document and escalate negotiations in cases where the behavior of the OEM was either


15

unreasonable or uncooperative. No documented instances were present for the 35 orders reviewed where the contracting officers escalated negotiations to support price reasonableness determinations. The unreasonable and uncooperative cases included declining to quote or refusing to provide information other than cost or pricing data that includes uncertified cost or pricing data for cost analysis to support price reasonableness determinations. As provided in the January 2001 memorandum from the Under Secretary of Defense for Acquisition and Technology on commercial items, “Sometimes, sole-source suppliers may attempt to exploit the lack of competitive markets and demand unreasonable prices.”

IG DoD Report No. D-2001-129, “Contracting Officer Determinations of Price Reasonableness When Cost or Pricing Data Were Not Obtained,” May 30, 2001, recommends that the Under Secretary of Defense for Acquisition, Technology, and Logistics emphasize to contracting officers the responsibility for identifying contractors that refuse to provide data contracting officials request and then institute corrective measures that include involving the head of the contracting activity. The report identifies the same problems at both AMCOM and DLA relating to commercial items with little or no sales outside DoD. The report states that the contracting officers were accepting commercial prices from contractors and not obtaining sufficient cost information to perform cost analysis to determine price reasonableness.

In response to the report, the Director, Defense Procurement agreed that circumstances leading to customer dissatisfaction, such as the denial of data contracting officials request, should be a part of the overall past performance evaluation of a contractor.

FAR 42.1501 states that past performance information includes “the contractor’s history of reasonable and cooperative behavior and commitment to customer satisfaction; and generally, the contractor’s business-like concern for the interest of the customer.”

The Director, Defense Procurement also provided a memorandum to the acquisition community on March 21, 2002, “Price Analyses and Price Reasonableness Determinations When Cost or Pricing Data Are Not Obtained,” that states:

A contractor that refuses to provide necessary information may be rendered ineligible for award unless the Head of the Contracting Activity determines otherwise, in accordance with FAR 15.403-3 (a) (4). As such, it is important that contractor refusals to provide requested pricing information receive the attention of levels of management higher than the contracting officer, and that contracting officers document the extent of their efforts to obtain needed information.

When an OEM refuses to quote an item and requires that DoD contracting officers procure the item from an exclusive distributor that provides limited value to DoD or when an OEM refuses to provide information other than cost or pricing data that includes uncertified cost or pricing data for cost analysis as required by the FAR clearly demonstrates unreasonable and uncooperative behavior by the

16

contractor. Cases of unreasonable and uncooperative behavior by the OEM should be documented and elevated for resolution to the Senior Procurement Executive and, if necessary, to the head of the agency.

Strategic Supplier Alliance

Contracting officers for AMCOM and DLA had not established an SSA with either AAR Defense Systems or Hamilton Sundstrand. An SSA is a framework implemented at the senior level that has been used successfully to develop a consensus of better contracting processes to produce optimum performance and price. In a memorandum dated May 13, 2002, the Director, Acquisition Initiatives stated that the Principal Deputy, Under Secretary of Defense for Acquisition, Technology, and Logistics met with the Senior Acquisition Executives for the DoD Components and discussed opportunities for SSAs. In conjunction with the first SSA award, which was made to Honeywell in June 2000, the total number of SSA partnerships executed or planned through FY 2004 is now 19 and includes Boeing, AVIBANK Manufacturing, and Lockheed-Martin. The Director, DLA together with the Commander of the Air Force Materiel Command jointly signed charters for alliances with Pratt and Whitney and General Electric in September 2002.

DLA had initiated an SSA with Hamilton Sundstrand in August 2000; however, the first attempt was unsuccessful. In light of the other successful SSAs, we believe that AMCOM and DLA, in conjunction with the Air Force, should initiate action to implement a new SSA with either AAR Defense Systems or Hamilton Sundstrand.

17

Conclusion

Contracting officers for AMCOM and DLA were unable to procure spare parts directly from the OEM and obtain adequate information other than cost or pricing data. As a result, AMCOM and DLA paid $16.8 million instead of $ 15 million, or 15 percent ($ 15 million) more than fair and reasonable prices on 35 orders (29 contracts) for 11 sole-source Hamilton Sundstrand spare parts procured from AAR Defense Systems from March 1999 through August 2002. Based on annual demand and the most recent prices paid, we calculate that DoD will pay about $22.2 million, or 15 percent more than fair and reasonable prices for the same items in FYs 2004 through 2009 if the problems are not corrected. Of the $22.2 million, 15 percent or $ 15 million represents the average pass-through costs from AAR Defense Systems. Table 6 shows the funds that could be put to better use if AMCOM and DLA can negotiate fair and reasonable prices.

15 This figure was calculated using contractor proprietary data and has been deleted.

Table 6. Summary of Funds Put to a Better Use With Fair and Reasonable Prices Current Prices Fair and Reasonable Prices

NSN ADQ1 Unit Price Total Unit price Total Difference

AMCOM 2835-01-208-77892 45 $ 2,579.73 $ 116,088 $ 15 $ 15 $ 15 2835-01-106-9156 144 4,936.24 710,819 15 15 15 2835-01-419-2118 41 8,813.40 361,349 15 15 15 2835-00-176-8867 41 3,664.98 150,264 15 15 15 Subtotal $ 1,338,520 $ 15 $ 15 DSCC 2520-00-153-2652 77 4,411.55 339,689 15 15 15 Subtotal $ 339,689 $ 15 $ 15 DSCP/DSCR 3895-01-446-8522 280 15,573.07 $4,360,460 15 15 15 Subtotal $4,360,460 $ 15 $ 15 DSCR 2835-00-015-8599 20 8,285.31 165,706 15 15 15 2835-01-462-3375 226 4,166.58 941,647 15 15 15 2835-00-104-7376 50 3,813.16 190,658 15 15 15 2835-00-962-5838 77 5,269.99 405,789 15 15 15 2835-00-963-1393 154 1,184.20 182,367 15 15 15 Subtotal $1,886,167 $ 15 $ 15 Total $7,924,836 $ 15 $ 15 Calculated cost difference from FY 2004 to FY 2009 ( 15 ) $ 15 1Annual Demand Quantity. 2 NSN 2835-01-208-7789 replaces NSN 2835-01-106-9153.

18

Management Comments on the Finding and Audit Response

Summaries of management comments on the finding and our audit response are in Appendix E.

Recommendations, Management Comments, and Audit Response

We recommend that the Commander, Army Aviation and Missile Command and the Director, Defense Logistics Agency emphasize with their contracting officers the need to:

1. Revisit procuring sole-source Hamilton Sundstrand spare parts from a distributor versus directly from the original equipment manufacturer or develop a business case that supports the use of an exclusive distributor to provide inventory stockage and materiel distribution requirements.

Defense Logistics Agency Comments. The Director of Logistics Operations concurred, stating that the DSCR Integrated Supplier Team for Hamilton Sundstrand has had several discussions with Hamilton Sundstrand managers on this recommendation and advised that the company is willing to provide pricing information for approximately 50 to 70 sole-source NSNs for stock support as well as agrees to pursue a long-term corporate contract. A solicitation is expected to be issued in the near future and will include provisions for adding more sole-source Hamilton Sundstrand spare parts DSCC, DSCP, DSCR, and possibly the Services manage.

Army Comments. The Deputy Assistant Secretary of the Army (Policy and Procurement) did not concur, stating that AMCOM contracting officers initiated action to procure spare parts directly from Hamilton Sundstrand with a goal for contract award in March 2004 “months” before receiving the IG DoD draft audit report.

Audit Response. Although the Army did not concur, we consider the comments responsive. The actions the contracting officers for AMCOM took to procure items directly from Hamilton Sundstrand satisfy the intent of the recommendation.

2. Obtain information that is adequate for evaluating reasonableness of price in accordance with Federal Acquisition Regulation requirements. The information--information other than cost or pricing data--includes uncertified cost or pricing data from the original equipment manufacturer that can be used to perform cost analysis to support price reasonableness determinations.

Defense Logistics Agency Comments. The Director of Logistics Operations partially concurred, stating that although contracting officers have a responsibility for determining price reasonableness, they individually have little leverage in

19

obtaining uncertified cost data from companies other than those with whom they are contracting. However, the course of action addressed in response to Recommendation 4. should enhance DLA ability to obtain such information.

Audit Response. We consider the DLA comments responsive.

Army Comments. The Deputy Assistant Secretary of the Army (Policy and Procurement) did not concur, stating that AMCOM has a policy and practice of negotiating fair and reasonable prices in accordance with FAR requirements and other applicable regulatory guidance. Additionally, the Deputy Assistant Secretary of the Army (Policy and Procurement) stated that some form of cost analysis was performed that supported price reasonableness when information other than cost and pricing data was used in most instances of AMCOM requirements and that contracting officer “judgment” was applied with regard to the prices reflected in contract awards.

Audit Response. The Army comments are not responsive. Although the contracting officers followed procedures, their “judgment” to accept data the OEM supplied without testing the validity of the data resulted in the Army’s paying prices too high for spare parts. Based on the results of the audit, the Army needs to perform some data tests that ensure contractors are supplying accurate information other than cost and pricing data. We request that the Army reconsider its position on the recommendation and provide additional comments in response to the final report.

3. Document and escalate negotiations when an original equipment manufacturer’s behavior is either unreasonable or uncooperative. This unreasonable and uncooperative behavior includes refusing to quote an item and requiring DoD contracting officers to procure the item from an exclusive distributor that provides limited value to DoD or refusing to provide information other than cost or pricing data (to include uncertified cost or pricing data) as required by the Federal Acquisition Regulation.

Defense Logistics Agency Comments. The Director of Logistics Operations partially concurred, stating that an OEM decision concerning whether to sell products directly or through any alternative means is not subject to any statutory or regulatory peacetime constraints. The Director of Logistics Operations concurred that when major adverse situations of this nature occur, the matter should be escalated within Government and OEM management channels for resolution or remediation.


Army Comments. The Deputy Assistant Secretary of the Army (Policy and Procurement) did not concur, stating that all AMCOM contracts for the four NSNs reviewed contained determinations that prices were fair and reasonable. Further, elevating negotiations is merely one technique that contracting officers should consider.

Audit Response. The Army comments are not responsive. Even though contracting officers determined that prices were fair and reasonable, the prices

20

were too high because the validity of the data used to support prices was not tested. Although FAR 15.404-3, “Subcontract Pricing Considerations” does place primary responsibility on the prime contractor to evaluate subcontractor proposals, the contracting officer has ultimate responsibility for determination of the price reasonableness for the prime contract, including subcontracting costs. The Defense Federal Acquisition Regulation Supplement 215.404-3, “Subcontract Pricing Considerations,” also emphasizes situations where the contracting officer should request audit or field pricing assistance to analyze and evaluate the proposal of a subcontractor. Two such instances--if a business relationship between the contractor and the subcontractor is not conducive to independence and the contractor is a sole-source supplier with the subcontract costs representing a substantial part of the contract cost--apply here. We believe that contracting officers should use all of the tools available to obtain fair and reasonable prices, including elevating negotiations when necessary to obtain sufficient data to ensure prices are truly fair and reasonable. We request that the Army reconsider its position on the recommendation and provide additional comments in response to the final report.

4. In conjunction with the Air Force, initiate action to implement a new Strategic Supplier Alliance with either AAR Defense Systems or Hamilton Sundstrand.

Defense Logistics Agency Comments. The Director of Logistics Operations concurred, stating that DLA is in the very early stages of formulating an SSA with Hamilton Sundstrand by identifying and obtaining confirmation from additional potential stakeholders, including the Army and Air Force. The Director of Logistics Operations did not concur with implementing an SSA with AAR at this time because current SSA efforts and resources for DLA are aimed at engaging OEMs of sole-source spare parts.


Army Comments. The Deputy Assistant Secretary of the Army (Policy and Procurement) did not concur, stating that AMCOM contracting officers initiated action for procuring spare parts directly from Hamilton Sundstrand with a goal for contract award in March 2004 months before receiving the IG DoD draft audit report.

Audit Response. The Army comments are not responsive. We believe that an SSA with Hamilton Sundstrand that involves all the potential stakeholders, including DLA, the Army, and the Air Force, has a much greater chance for success. We request that the Army reconsider its position on the recommendation and provide additional comments in response to the final report.

21

Appendix A. Scope and Methodology

We visited or contacted individuals and organizations within DoD, AAR Defense Systems, and Hamilton Sundstrand. We reviewed 35 orders (29 contracts) for 11 different Hamilton Sundstrand sole-source spare parts (NSNs) procured between March 1999 and August 2002 from AAR Defense Systems with a total value of $16.8 million. The Haystack Online for Windows showed 566 parts ordered from AAR Defense Systems from March 1999 to August 2002 valued at $64.1 million. Of the 566 parts, 89 made up $57.6 million or 90 percent of the $64.1 million. During the period reviewed, DoD awarded 311 orders for the 89 parts. Our verification showed that Hamilton Sundstrand was the OEM for 87 of the 89 spare parts. We selected 11 of the 87 spare parts that were high dollar items for our review.

We reviewed information other than cost or pricing data from AAR Defense Systems that included the price charged by the OEM, Hamilton Sundstrand, and additional pass-through costs charged to DoD. We obtained standard manufacturing cost data for 2000, 2001, and 2002 from Hamilton Sundstrand. We also reviewed Hamilton Sundstrand commercial sales data from January 2000 through June 2002.

We reviewed delivery orders, contract awards, price negotiation memorandums, and correspondence within the contract files and Haystack Online for Windows database to determine whether DoD Components were receiving fair and reasonable prices and whether AAR Defense Systems was providing added value to DoD by acting as a distributor for Hamilton Sundstrand.

We performed this audit from November 2001 through March 2003 in accordance with generally accepted government auditing standards.

Use of Computer-Processed Data. We relied on computer-processed data from the Haystack Online for Windows database to determine the contracting activities to visit and to determine audit sample selection. Although we did not perform a formal reliability assessment of the computer-processed data from the Haystack Online for Windows database, we determined that the contract numbers, award dates, and contractors on the contracts reviewed generally agreed with the information in the computer-processed data. We did not find errors that would preclude use of the computer-processed data to meet the audit objectives or that would change the conclusions in this report.

We also relied on Hamilton Sundstrand’s cost estimating system for standard manufacturing cost data to determine fair and reasonable prices for spare parts. We did not validate the data; however, DCAA performed audits in 1997 and 1999 on Sundstrand Aerospace Corporation’s costs estimating system and stated that internal controls and procedures of the cost estimating system were adequate. Sundstrand Aerospace Corporation has undergone changes in their corporate structure since DCAA performed the audits. DCAA is performing an audit on Hamilton Sundstrand’s cost estimating systems and expects to issue a draft report of that audit in October 2003.

22

General Accounting Office High-Risk Area. The General Accounting Office (GAO) has identified several high-risk areas in DoD. This report provides coverage of the DoD Contract Management and Inventory Management high-risk areas.

Management Control Program Review

DoD Directive 5010.38, “Management Control (MC) Program,” August 26, 1996, and DoD Instruction 5010.50, “Management Control (MC) Program Procedures,” August 28, 1996, require DoD organizations to implement a comprehensive system of management controls that provide reasonable assurance that programs are operating as intended and to evaluate the adequacy of the controls.

Scope of the Review of the Management Control Program. We reviewed DSCR, DSCC, and AMCOM’s adequacy of management controls of contract management. Specifically, we reviewed management controls over price reasonableness determinations. We also reviewed management’s self-evaluation applicable to those controls.

Adequacy of Management Controls. We identified management control weaknesses for AMCOM, DSCC, and DSCR as DoD Instruction 5010.40 defines. AMCOM, DSCC, and DSCR controls for contract management were insufficient to make sure that price reasonableness determinations resulted in DoD receiving a fair and reasonable price for the 11 spare parts reviewed. Recommendations 1., 2., and 3., if implemented, will improve contract management procedures and could result in potential monetary benefits. DLA conducted a Procurement Management Review in June 2001 on the pricing of first-time buys that identified management control weaknesses. Although DLA identified the management control weaknesses, problems still exist in determining fair and reasonable prices. A copy of the final report will be sent to the senior official in charge of management controls for DLA and AMCOM.

Adequacy of Management’s Self-Evaluation. In the FY 2001 Annual Statement of Assurance, DLA identified the pricing of first-time buys as an assessable unit and reported that as a management concern for DSCR and DSCC. In addition, DSCR and DSCC provided price reasonableness determination training in FY 2002 for all contracting officers and buyers. AMCOM did not identify contract management as an assessable unit in its FY 2001 Annual Statement of Assurance and, therefore, did not identify price reasonableness determinations as a management concern or material weakness.

23

Appendix B. Prior Coverage

During the last 5 years, GAO and the IG DoD have issued 21 reports discussing spare parts and price reasonableness determinations. Unrestricted GAO reports can be accessed over the Internet at http://www.gao.gov. Unrestricted IG DoD reports can be accessed at http://www.dodig.osd.mil/audit/reports.

GAO

GAO, Report No. GAO-02-502, “DoD Needs Better Guidance on Granting Waivers for Certified Cost or Pricing Data,” April 22, 2002

GAO, Report No. GAO-01-772, “Army Inventory: Parts Shortages Are Impacting Operations and Maintenance Effectiveness,” July 31, 2001

GAO, Report No. GAO-01-587, “Air Force Inventory: Parts Shortages Are Impacting Operations and Maintenance Effectiveness,” June 27, 2001

GAO, Report No. GAO-01-22, “Defense Acquisitions: Price Trends for the Defense Logistics Agency’s Weapon Systems Parts,” November 3, 2000

GAO, Report No. GAO/NSIAD-00-30, “Defense Inventory: Opportunities Exist to Expand the Use of Defense Logistics Agency Best Practices,” January 26, 2000

GAO, Report No. GAO/NSIAD-00-22, “Contract Management: A Comparison of DoD and Commercial Airline Purchasing Practices,” November 29, 1999

GAO, Report No. GAO/NSIAD-00-21, “Defense Inventory: Management of Repair Parts Common to More than one Military Service can be Improved," October 20, 1999

GAO, Report No. GAO/NSIAD-99-90, “Contract Management: DoD Pricing of Commercial Items Needs Continued Emphasis,” June 24, 1999

IG DoD

IG DoD Report No. D-2002-112, “Industrial Prime Vendor Program at the Air Force Air Logistics Centers,” June 20, 2002

IG DoD Report No. D-2002-059, “Results of the Defense Logistics Agency Strategic Supplier Alliance with Honeywell International, Incorporated,” March 13, 2002

IG DoD Report No. D-2001-171, “Industrial Prime Vendor Program at the Naval Aviation Depot – Cherry Point,” August 6, 2001

24

IG DoD Report No. D-2001-129, “Contracting Officer Determinations of Price Reasonableness When Cost or Pricing Data Were Not Obtained,” May 30, 2001

IG DoD Report No. D-2001-072, “Industrial Prime Vendor Program at the Naval Aviation Depot – North Island,” March 5, 2001

IG DoD Report No. D-2000-99, “Procurement of the Propeller Blade Heaters for the C-130 and P-3 Aircraft,” June 12, 2000

IG DoD Report No. D-2000-98, “Spare Parts and Logistics Support Procured on a Virtual Prime Vendor Contract,” June 14, 2000

IG DoD Report No. 99-218, “Sole-Source Noncommercial Spare Part Orders on a Basic Ordering Agreement,” October 12, 1999

IG DoD Report No. 99-217, “Sole-Source Commercial Spare Parts Procured on a Requirements Type Contract, “ August 16, 1999

IG DoD Report No. 99-101, “Logistics Response Time for the Direct Vendor Delivery Process, Defense Supply Center, Columbus,” March 4, 1999

IG DoD Report No. 99-026, “Commercial Spare Parts Purchased on a Corporate Contract,” January 13, 1999

IG DoD Report No. 98-088, “Sole-Source Prices for Commercial Catalog and Noncommercial Spare Parts,” October 13, 1998

IG DoD Report No. 98-064, “Commercial and Noncommercial Sole-Source Items Procured on Contract N000383-93-G-M111,” February 6, 1998

25

Appendix C. Comparison of DoD Prices with Fair and Reasonable Prices

DoD Prices Fair and Reasonable Prices Difference NSN Contract/Order Date Quantity Unit Total Year16 Unit Total Amount Percent

AMCOM 2835-01-106-915317 DAAH2300P0066 Nov 99 30 2,372.00 71,160 2000 18 18 18 18 2835-01-106-9153 DAAH2300C0390 Sep 00 100 2,491.76 249,176 2000 18 18 18 18 2835-01-106-915319 1.035303862 2002 2,579.73 2002 18 18

2835-01-106-9156 DAAH2300P1175 Sep 00 90 4,815.84 433,426 2000 18 18 18 18 2835-01-106-9156 DAAH2300P1175 May 01 90 4,936.24 444,262 2001 18 18 18 18 2835-01-106-9156 DAAH2302C0080 Jan 02 228 4,936.24 1,125,463 2002 18 18 18 18 2835-01-419-2118 DAAH2300C0194 Jun 00 75 8,468.98 635,174 2000 18 18 18 18 2835-01-419-2118 DAAH2302C0085 Dec 01 75 8,666.22 649,967 2001 18 18 18 18

2835-01-419-211819 1.016983627 2002 8,813.40 2002 18 18

2835-00-176-8867 DAAH2300C0364 Sep 00 60 3,540.00 212,400 2000 18 18 18 18 2835-00-176-886719 1.035303862 2002 3,664.98 2002 18 18

AMCOM Subtotal 3,821,026 18 18 18

16We did not obtain standard data from Hamilton Sundstrand for 1999. 17NSN 2835-01-106-9153 will be replaced by NSN 2835-01-208-7789 in the future. 18This figure was calculated using contractor proprietary data and has been deleted. 19We used Navy Inflation Indices of 1.035 to calculate prices from 2000 to 2002 and 1.017 to calculate prices from 2001 to 2002.

26

DoD Prices Fair and Reasonable Prices Difference

NSN Contract/Order Date Quantity Unit Total Year16 Unit Total Amount Percent

DSCC

2520-00-153-2652 SP074099C2425 May 99 40 4,885.00 195,400 2000 18 18 18 18 2520-00-153-2652 SP075000C3755 Dec 99 75 4,261.00 319,575 2000 18 18 18 18 2520-00-153-2652 SP075000C3794 April 00 80 4,261.12 340,890 2000 18 18 18 18 2520-00-153-2652 SP075000C3814 Jul 00 60 4,261.00 255,660 2000 18 18 18 18 2520-00-153-2652 SP075000C3711 Sep 00 61 4,261.12 259,928 2000 18 18 18 18

2520-00-153-265219 1.035303862 2002 4,411.55 2002 18 18

DSCC Subtotal 1,371,453 18 18 18

DSCP 3895-01-446-8522 SP056000ML044 May 00 2 14,584.00 29,168 2000 18 18 18 18 3895-01-446-8522 SP056000C0066 Sep 00 25 14,584.00 364,600 2000 18 18 18 18 3895-01-446-8522 SP056002C0200 Nov 01 90 15,313.00 1,378,170 2001 18 18 18 18 3895-01-446-852219 1.016983627 2002 15,573.07 2002 18 18 DSCP Subtotal 1,771,938 18 18 18

27

DoD Prices Fair and Reasonable Prices Difference NSN Contract/Order Date Quantity Unit Total Year16 Unit Total Amount Percent

DSCR 2835-00-015-8599 SP041199MEC01 Mar 99 1 7,269.00 7,269 2000 18 18 18 18 2835-00-015-8599 SP041199C5452 May 99 25 7,269.00 181,725 2000 18 18 18 18 2835-00-015-8599 SP048099D05640001 Sep 99 200 7,269.12 1,453,824 2000 18 18 18 18 2835-00-015-8599 SP048099D05640002 Aug 00 40 8,146.95 325,878 2000 18 18 18 18 2835-00-015-8599 SP048099D05640003 Feb 01 160 8,146.95 1,303,512 2001 18 18 18 18 2835-00-015-859919 1.016983627 2002 8,285.31 2002 18 18

2835-01-462-3375 SP048000C5228 Dec 99 130 3,592.96 467,085 2000 18 18 18 18 2835-01-462-3375 SP048000G0001TY91 Aug 01 42 3,932.50 165,165 2001 18 18 18 18 2835-01-462-3375 SP048000G0001TY95 Nov 01 380 3,900.00 1,482,000 2001 18 18 18 18 2835-01-462-3375 SP048000G0001TY95 Nov 01 380 4,097.00 1,556,860 2001 18 18 18 18 2835-01-462-337519 1.016983627 2002 4,166.58 2002 18 18 2835-00-104-7376 SP048000G0001TY67 Mar 01 36 3,692.94 132,946 2001 18 18 18 18 2835-00-104-7376 SP048000G0001TY2W Jun 02 223 3,813.16 850,335 2002 18 18 18 18

2835-00-962-5838 SP048000G0001TY66 Apr 01 39 4,567.75 178,142 2001 18 18 18 18 2835-00-962-5838 SP048000G0001TY66 May 01 39 4,796.15 187,050 2001 18 18 18 18 2835-00-962-5838 SP048000G0001TY1X Dec 01 79 5,019.04 396,504 2001 18 18 18 18 2835-00-962-5838 SP048000G0001TY1X May 02 79 5,269.99 416,329 2002 18 18 18 18 2835-00-963-1393 SP048000MA259 Dec 99 45 1,021.00 45,945 2000 18 18 18 18 2835-00-963-1393 SP048000G0001TY04 April 00 97 1,075.00 104,275 2000 18 18 18 18 2835-00-963-1393 SP048000G0001TY65 May 01 418 1,089.00 455,202 2001 18 18 18 18 2835-00-963-1393 SP048000G0001TY3T Aug 02 79 1,184.20 93,552 2002 18 18 18 18 DSCR Subtotal 9,803,598 18 18 18 Total 16,768,014 18 18 18

28

Appendix D. Management Comments on the Finding and Audit Response

DLA Comments on the Finding

Limited Data Available to DLA Contracting Officers. The Director of Logistics Operations commented that based on the limited data available, DLA contracting officers determined that the prices were not fair and reasonable for two contracting actions and reported that the prices could not be determined fair and reasonable in seven other instances. The Director of Logistics Operations also commented that DLA contracting officers were unable to obtain the cost data later provided by Hamilton Sundstrand to the IG DoD.

Audit Response. Based on comments received from DLA and discussions with the Army, the IG DoD revised the finding paragraph to acknowledge that the cost data Hamilton Sundstrand provided to the IG DoD was not made available to the contracting officers. We agree that without the cost data IG DoD obtained, contracting officers would not have been able to determine that prices were too high for the contracting actions.

Methodology for Calculating Fair and Reasonable Prices. The Director of Logistics Operations commented that neither the IG DoD methodology for calculating prices deemed fair and reasonable for the Government to pay for Hamilton Sundstrand parts was explained nor were the actual calculations of the IG DoD provided in the draft.

Audit Response. The IG DoD briefed and provided data to representatives from the DSCR cost and pricing group on the IG DoD calculations of fair and reasonable prices. The data were also provided to DLA headquarters representatives. In addition, the IG DoD audit team has extensive experience pricing spare parts procured from various contractors including Hamilton Sundstrand and the calculations were also briefed to Hamilton Sundstrand representatives (see Appendix B, Prior Coverage, IG DoD). Our calculations and methodology are always available to DLA personnel.

Recognizing a Reasonable Profit Margin for AAR Defense Systems. The Director of Logistics Operations commented that it is reasonable to allow contractor markups and profit commensurate with the value of services provided. The Director also commented that DLA contracting officers had no alternative but to buy Hamilton Sundstrand sole-source parts from AAR Defense Systems and to recognize AAR Defense Systems costs and a reasonable profit margin, regardless of the existence and extent of any value-added services AAR Defense Systems would provide.

Audit Response. Statements appear to be contradictory. However, the actions DLA took to procure items directly from Hamilton Sundstrand should resolve this issue.

29

Army Comments on the Finding Failing to Negotiate Fair and Reasonable Prices. The Deputy Assistant Secretary of the Army (Policy and Procurement) commented that the AMCOM practice is to comply with all regulatory and statutory requirements when negotiating fair and reasonable prices.

Audit Response. Based on comments received from the Army, the IG DoD revised the finding paragraph to acknowledge that AMCOM and DLA contracting officers followed established procedures and with available information generally determined prices fair and reasonable for sole-source spare parts procured from AAR Defense Systems--an exclusive distributor for Hamilton Sundstrand.

Commerciality of Hamilton Sundstrand Spare Parts. The Deputy Assistant Secretary of the Army (Policy and Procurement) commented that the FAR does not base the determination of commerciality of parts on comparison of military to commercial sales. In addition, the Army commented that AMCOM has commercial pricing for the four AMCOM NSNs and that two of the NSNs (specifically, NSN 2835-01-106-9153 and NSN 2835-00-176-8867) are not commercial “of a type.”

Audit Response. The FAR definition of a commercial item specifically states that a commercial item is customarily used by the public or by non-Governmental entities for purposes other than Governmental purposes. Therefore, military sales do not support commerciality. Further, the IG DoD obtained sales history information from Hamilton Sundstrand. The information referenced 148 sales for part numbers identical or “of a type” for NSN 2835-01-106-9153. Our review of the information identified 100 of the sales were to AAR Defense Systems (Hamilton Sundstrand’s distributor for military sales). The other 48 sales were to foreign governments or companies performing work for both commercial and Government entities where the end-user could not be identified. Therefore, we characterized those sales as commercial. The IG DoD used Hamilton Sundstrand’s sales history data to characterize parts as commercial “of a type.” Contracting officers must verify whether sales histories provided as support of commerciality are in fact sales to the government. If so, the sales clearly do not qualify as commercial sales.

Methodology for Calculating Fair and Reasonable Pricing. The Deputy Assistant Secretary of the Army (Policy and Procurement) commented that although the Army could not determine exactly how the IG DoD calculated the fair and reasonable prices, the Army believes the prices are significantly understated. The Army also commented, “Although we requested the ‘cost data’ utilized by the DODIG in their evaluation, the DODIG did not provide the cost data for our review.” Additionally, the Army commented that it believes that the IG DoD used questionable methods to calculate fair and reasonable prices, such as not considering quantities as a factor.

Audit Response. The IG DoD has extensive experience in calculating fair and reasonable prices using cost data. We have performed similar audits at Boeing, Hamilton Sundstrand, Honeywell, Bell Helicopter, and BF Goodrich (see Appendix B, Prior Coverage, IG DoD). Audit team members have also supported

30

the DLA/Honeywell SSA and provided guidance and support using cost data to price thousands of individual spare parts. In addition, the calculations were briefed to Army headquarters representatives and also to Hamilton Sundstrand representatives. As previously stated, explanations of the calculations, methodology, and data were and are always available to Army personnel. In regard to the quantities issue, Hamilton Sundstrand uses a standard cost estimating system to price spare parts. Prices in standard cost estimating systems generally do not vary based on different quantities. In addition, Hamilton Sundstrand did not identify any policy relating to different quantities that would affect its standard costs, we used the appropriate standard for each year, and we found only minimal differences in the standards for the same parts from year to year regardless of the quantities ordered.

Obtaining Information Other than Cost or Pricing Data. The Deputy Assistant Secretary of the Army (Policy and Procurement) commented that AMCOM contracting officers requested and received information other than cost or pricing data to support the fair and reasonable price determinations made for three of the four AMCOM NSNs.

Audit Response. The IG DoD recognizes that AMCOM contracting officers did request, receive, and rely on information other than cost or pricing data to support the fair and reasonable price determinations made for three of the four AMCOM NSNs. Unfortunately, this information was inaccurate and misleading. Consequently, we believe AMCOM contracting officers need to test in the future the validity of the data.

Quoted Lead Times as a Measure of Added Value. The Deputy Assistant Secretary of the Army (Policy and Procurement) commented that quoted lead times may not be an accurate judge of determining added value and that AAR was able to expedite orders to add value.

Audit Response. Because AAR Defense Systems was not stocking the Hamilton Sundstrand parts, the Army should have been just as successful as improving delivery times from Hamilton Sundstrand. Therefore, any improvement on the quoted lead-time would not be an added value that the Army could not also have obtained.

31

Appendix E. Report Distribution

Office of the Secretary of Defense Under Secretary of Defense for Acquisition, Technology, and Logistics Director, Acquisition Initiatives Director, Defense Procurement and Acquisition Policy Under Secretary of Defense (Comptroller)/Chief Financial Officer Deputy Chief Financial Officer Deputy Comptroller (Program/Budget)

Department of the Army Assistant Secretary of the Army (Financial Management and Comptroller) Auditor General, Department of the Army Commander, Army Materiel Command Commander, Army Aviation and Missile Command

Department of the Navy Naval Inspector General Auditor General, Department of the Navy

Department of the Air Force Assistant Secretary of the Air Force (Financial Management and Comptroller) Auditor General, Department of the Air Force

Other Defense Organizations Director, Defense Logistics Agency

Commander, Defense Supply Center Columbus Commander, Defense Supply Center Philadelphia Commander, Defense Supply Center Richmond

Non-Defense Federal Organizations and Individuals Office of Management and Budget

Defense Logistics Agency Comments

33

Final Report Reference

34

Darkened areas of this page represent contractor proprietary data that has been deleted. Revised Pages i, 3, and 7


35

Darkened areas of this page represent contractor proprietary data that has been deleted.

Department of the Army Comments

40


44



45

Revised Pages i, 3, and 7


46



47



48

Revised Pages i, 2, 3, 16, 20, 24, and 26

Team Members The Contract Management Directorate, Office of the Deputy Inspector General for Auditing of the Department of Defense prepared this report. Personnel of the Office of the Inspector General of the Department of Defense who contributed to the report are listed below.

Robert K. West Henry F. Kleinknecht Ronald W. Hodges Lorin T. Pfeil Robert P. Goldberg Nicole M. Ellis

Acquisition - Defense Technical Information Center

Documents

Transcript of Acquisition - Defense Technical Information Center